November 2011

Tuesday, November 22, 2011

The last week has been a non-stop flood of news. And, quite honestly, none of it is encouraging. I imagine the sole exception to that rule is the relatively sanguine nature of the US data. That said, I remain unconvinced that the US can for much longer resist the downward pull of the rest of the globe.

What more can we say about Europe that has not already been said? There has been no forward progress in the past week. To be sure, ECB bond buying has helped keep a lid on Italian bond yields. Yet, while ECB monetary policymakers focus on Italy, Spain and Belgium are slipping away. And France is clearly the next domino to fall. The "accidental" downgrade last week simply reveals that S&P has already prepared the report, clearly anticipating a deterioration in France's budget position as the Eurozone recession deepens. And to make matters worse, Zero Hedge points us to signs the Dexia bank rescue is faltering, and the Belgians realize they need to shift more of that burden of that rescue onto France. Meanwhile, the situation in Eastern Europe is rapidly deteriorating - Yves Smith directs us to the Telegraph for that story. And in Greece, the opposition party still insists they will not sign any pledge to commit to the October deal. Was any deal really reached last month?

Conventional wisdom is that the European Central Bank eventually acts as a lender of last resort to alleviate the sovereign debt crisis. This was clearly not on the mind of ECB President Mario Draghi in his recent speech. I certainly hope something was lost in translation, as the speech has some memorable moments. Notably:

Activity is expected to weaken in most of the advanced economies. This is the result of a weakening of various components of aggregate demand, both domestic and foreign.

Economic activity is weakening because the underlying components of economic demand are weakening. I am not sure this is particularly insightful. Is this the best analysis he can muster from the intellectual firepower of ECB economists? If so, we are in very big trouble. But it continues. The first two of Draghi's three pillars of monetary policy:

Continuity first and foremost refers to our primary objective of maintaining price stability over the medium term.

Consistency means to act in line with our primary objective and with our strategy both in time and over time.

I am having a hard time distinguishing between "continuity" and "consistency" here. The third (second?) pillar is predictable:

Credibility implies that our monetary policy is successful in anchoring inflation expectations over the medium and longer term. This is the major contribution we can make in support of sustainable growth, employment creation and financial stability. And we are making this contribution in full independence.

Gaining credibility is a long and laborious process. Maintaining it is a permanent challenge. But losing credibility can happen quickly – and history shows that regaining it has huge economic and social costs.

Translation: "We can only save the Euro, but only at the cost of German hyperinflation of the 1920's." He then pulls a Ben Bernanke and tosses the ball back to fiscal policymakers"

National economic policies are equally responsible for restoring and maintaining financial stability. Solid public finances and structural reforms – which lay the basis for competitiveness, sustainable growth and job creation – are two of the essential elements.

But in the euro area there is a third essential element for financial stability and that must be rooted in a much more robust economic governance of the union going forward. In the first place now, it implies the urgent implementation of the European Council and Summit decisions. We are more than one and a half years after the summit that launched the EFSF as part of a financial support package amounting to 750 billion euros or one trillion dollars; we are four months after the summit that decided to make the full EFSF guarantee volume available; and we are four weeks after the summit that agreed on leveraging of the resources by a factor of up to four or five and that declared the EFSF would be fully operational and that all its tools will be used in an effective way to ensure financial stability in the euro area. Where is the implementation of these long-standing decisions?

Here I think that Draghi is simply delusional. Does he not realize that plans to expand the ESFS are essentially dead at this point? That France and Germany are not willing or able to contribute more capital? That the plans to leverage the ESFS are floundering as the reality sets in that financial engineering will not work here? That the Chinese scoffed at efforts to get them to buy into such a plan? That the EU political system is capable at moving even a fraction of the speed of financial markets?

I understand the ECB does not want to take on the role of fiscal authority, but what other choice do they have? Little else than to oversee the collapse of the currency they are charged to protect.

Meanwhile, word is the Greek debt haircut deal is in jeopardy. Not a surprise, as not real was really reached at the summit, just a desperate attempt to buy time. Market participants should by now realize the outcome of any European summit is little more than smoke and mirrors.

Speaking of smoke and mirrors, the news from this side of the pond is not exactly encouraging. The Supercommitte hit a brick wall, to no one's surprise but Wall Street's. The stage is set for a nontrivial fiscal tightening in short order - 5 weeks or so. Greg Ip at the Economist puts some numbers on what is at stake, and comes up with contractionary policy on the order of 2.4% of GDP. Note that the Federal Reserve forecast for 2012 is 2.5% to 2.9%, and I bet not much fiscal contraction is built into those numbers. So, make no mistake, the failure of the Supercommittee to come up with a plan for "smart" austerity - austerity focused on the medium and long-runs, with stimulus in the short run, is very meaningful. The conventional wisdom is that Congress will not go home for the holidays without at a minimum extending the payroll tax credit. I will follow that lead, but remain worried that the weight of Washington gridlock argues for more disappointment in the weeks ahead.

Across the Pacific, another storm is brewing - the Chinese economy continues to slow. Via Bloomberg:

China’s manufacturing may contract this month by the most since March 2009 as home sales slide, adding to evidence the world’s second-biggest economy is slowing, a preliminary purchasing managers’ index shows.

The reading of 48 reported by HSBC Holdings Plc and Markit Economics today compares with a final number of 51 last month. A number below 50 indicates a contraction.

Conventional wisdom is that the downside is limited, as at its heart China is a command and control economy. That said, even a minor slowdown is disconcerting, as the US economy does not need another trade shock to add to the trade and, more importantly, financial shock about to flow from Europe.

Bottom Line: The world economy remains in a precarious place as we head into the final month of 2011.

Tuesday, November 15, 2011

The Eurozone is stuck on a path that leads to a very nasty equilibrium. From the Financial Times:

In a day that euro-era records tumbled, Italian yields moved through 7 per cent – a level viewed as unsustainable – for the second time in a week. The Spanish premium to Germany hit 482bp, above the critical 450bp rate at which Irish and Portuguese yields spiralled out of control and forced both countries into international bail-outs. Belgium also saw its bonds’ spread over German debt reach record levels of 314bp.

Europe’s economic expansion failed to accelerate in the third quarter as Germany and France struggle to shore up a region bracing for a recession sparked by an escalating debt crisis.

Gross domestic product increased 0.2 percent from the previous three months, when it rose at the same pace, the European Union’s statistics office in Luxembourg said in a statement today. That matched the median forecast of 39 economists surveyed by Bloomberg News. From a year-earlier, GDP increased 1.4 percent. A separate report showed that German investor confidence fell to a three-year low in November.

One would normally anticipate that as growth decelerated, bond yields would fall in expectation of monetary easing. Not so in Europe, as slower growth fosters fear of sovereign default as deficits widen. As is well known at this juncture, the response of policymakers will be to enact deeper austerity measures, which will in turn slow growth further. Not what one would call a path to a good equilibrium.

For its part, the ECB continues to dabble in bond markets, although to limited effect, failing to hold Italian yields below 7%. Market participants are convinced that the ECB will step up to the plate eventually and act as a real lender of last resort, completely backstopping sovereign debt in the Eurozone. Monetary policymakers, however, are digging in their heels:

The president of Germany’s powerful Bundesbank has firmly rebuffed international demands for decisive intervention in the bond markets by the European Central Bank to combat the eurozone debt crisis, warning that such steps would add to instability by violating European law...“I cannot see how you can ensure the stability of a monetary union by violating its legal provisions,” Mr Weidmann argued. “I don’t see how you can build trust in a system that violates laws.”

Fiddling while Rome burns. Literally. One has to believe expectations of a ECB backstop are warranted, otherwise there is little if any hope for the Euro. That said, given ECB resistance to the idea, I am beginning to believe that we will need a "Lehman" event to force their hand - at which point, of course, it would already be game over for the European financial situation.

The ECB mops up the liquidity created by its purchases of distressed government bonds -- 183 billion euros ($251 billion) so far -- to prevent them from fueling inflation and ensure it can’t be accused of financing profligate governments.

Rabobank economist Elwin de Groot estimates that there is a “natural limit” of 300 billion euros the ECB can sterilize. “If it maintained a pace of 11 billion additional purchases each week, the average amount of purchases in the period August- September, it would hit that natural limit by mid-January,” De Groot said in a note to investors today.

When the ability to sterilize evaporates, the ECB will have to choose between expanding the balance sheet or ceasing to purchase additional Italian and Spanish bonds. In the meantime, the ECB appears to be waiting for troubled European governments to enact just the right amount of austerity to boost confidence and send private investors scrambling for European debt. They seem to be completely ignorant that the debt-deflation dynamic in place only erodes confidence further.

Meanwhile, the Greece situation remains unresolved. From the Athens Times:

Greece's conservative party leader on Monday vowed to reject any toughening of austerity measures in return for a multi-billion euro bailout, signalling the new coalition government may not enjoy the kind of cross-party support demanded by lenders.

New Democracy leader Antonis Samaras said he would not vote for any new austerity measures and added that the policy mix of spending cuts and tax rises agreed with international lenders should be changed in favour of economic growth...

...Crucially, Samaras said he would not sign any letter pledging support for conditions on a 130bn euro bailout as EU Economic and Monetary Affairs Commissioner Olli Rehn has demanded.

Another game of chicken. One of the two must back down, it is thought, else the end result is something no one wants, an immediate Greek default. But here again is an opportunity for another Lehman moment.

And while the the European financial system remains in jeopardy, a heavily trumpeted, supposedly key piece of the firewall, remains mired in technical difficulties, as efforts to leverage up the EFSF look doomed to fail. From Reuters:

Efforts to amplify the power of the euro zone's rescue fund and convince markets the bloc can handle its debt crisis risk being undermined by delays, surging bond yields and limited investor interest, potentially ruining the plan altogether.

Side note - Isn't investor participation in the EFSF inherently risky from Europe's point of view? What is to prevent market participants from launching a speculative attack on both the bonds of the EFSF and the bonds of trouble nations? Indeed, it seems like the existence of a investor dependent ESFS would only enhance the power of speculative attacks. What am I missing hear?

Any way you cut it, the end result is recession in Europe. For Wall Street and Washington, the question remains: Will the US decouple, gaining traction while Europe flounders? Or will the US be caught in the downdraft? I remain cautious on the US outlook, despite recent possitive data. If the US suffers from Europe's malaise, I don't think it would be evident before next year, which means I take little solace in the near term data flow.

Bottom Line: The European situation remains tenuous. Indeed, I am not sure any real progress has been made in the last few months - certainly not if the bond markets are any guide. It will continue to get worse before it gets better, and I worry that a Lehman event will be the only thing that draws in the ECB.

Wednesday, November 09, 2011

Wall Street is again taking Europe seriously, at least for the moment. Today was unpleasant. The most important news of the day is that Germany and France are planning for a new Europe. From Reuters:

Merkel said Europe's plight was now so "unpleasant" that deep structural reforms were needed quickly, warning the rest of the world would not wait. "That will mean more Europe, not less Europe," she told a conference in Berlin.

She called for changes in EU treaties after French President Nicolas Sarkozy advocated a two-speed Europe in which euro zone countries accelerate and deepen integration while an expanding group outside the currency bloc stays more loosely connected -- a signal that some members may have to quit the euro.

"It is time for a breakthrough to a new Europe," Merkel said. "A community that says, regardless of what happens in the rest of the world, that it can never again change its ground rules, that community simply can't survive."

For the Eurozone to work, there needs to be greater fiscal integration. But Germany and France do not see a place for Greece and likely Italy, possibly Spain and Portugal as well, in such a fiscal union. And, in all honesty, it is hard to find fault with such a conclusion. The clearly dysfunctional behavior of the Italian and Greek governments has made it all but impossible to erect a firewall around the crisis at this point. The credibility of the Eurozone decision making process, allready severly weakened by the endless inconclusive summits, is now completely non-existent.

Interestingly, the IMF appears to be holding out hope that a firewall is still possible:

Christine Lagarde, head of the International Monetary Fund, told a financial forum in Beijing that Europe's debt crisis risked plunging the global economy into a Japan-style "lost decade."

"If we do not act boldly and if we do not act together, the economy around the world runs the risk of downward spiral of uncertainty, financial instability and potential collapse of global demand."...

..Lagarde said she was hopeful the technical details on boosting the European Financial Stability Fund (EFSF) to around 1 trillion euros would be ready by December.

How viable is the idea of leveraging up the EFSF now that Sarkozy and Merkel have openly breached the topic of a breaking of the Euro? Do the Europeans really take the Chinese for such fools that they will save the Euro when the economic backbone of the Continent no longer believes it is worth saving?

A wild card in this disaster is the European Central Bank. The calls for action are deafening, yet they apparently fall on deaf ears. I think we all agree that the ECB can at least put a floor under Italy, and arguably should be doing that to prevent what appears to be largely a liquidity crisis from becoming a solvency crisis. They would also send a strong signal that the Eurozone does in fact have a lender of last resort. Make no mistake, they can't stop the blinding painful recession that is about to descend upon Europe. That is already backed into the cake, and the ECB would put the icing on the top by calling for harsh austerity in any nation receiving its backstop. But they could prevent a depression. And everyone believes they will step up to the plate eventually.

But what if they don't? What if Germany and France absolutely forbid it? If Germany and France are already planning for a new Europe, they certainly don't want it to begin with a central bank holding a massive piece of the debt from those nations they intend to eject from the Euro. As it is, they probably already fear that a Greek default is inevitable in the next few months, and the ECB will be left holding the bag on their Greek debt holdings. Why add further to those potential/likely losses?

Now where is the Fed in all of this? Quiet, very quiet. To be sure, they will stand ready to provide dollar liquidity via swap agreements with their foreign counterparts. And will likely expand the balance sheet in the event of sharp deceleration in US economic acivity. But such a deceleration is not likely to be revealed in the near term data. And, interestingly, note that despite all the turmoil, the implied inflation rate via the TIPS market is 1.88 and 1.99 at the 5 and 10 year horizons, respectively. I believe the Fed would like to see clearer deflationary pressures before they engaged in another round of QE.

The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash before the increase in eurorisk leads American finance to tighten credit again and send us down into the double dip.

Here too it is probably already too late. The time to move was this summer.

At a minimum, the Fed could be preparing a credit facility to take European sovereign debt as collateral. Beyond that, I find it hard to imagine the Fed making large scale European debt purchases. After all, what will they define as an American financial instituion? Deutsche Bank has a US financial holding company - would a Fed commitment include all of Deutsche Bank's European bond portfolio? I don't think the Fed is ready to make such distinctions, especially after the public relations beating they took for lending to foreign banks during the US financial crisis.

In my opinion, they did not have a choice - the foreign banks are part of the US banking system and thus needed to be part of the emergency lending facilities. And, of course, the interconnectiveness of the European and US financial sectors argues for exactly what Brad proposes, even it if meant taking European debt off the hands of European banks. But isn't that the ECB's job? I find it hard to see the Fed eager to take on the role of global lender of last resort. Just as I find it difficult to see the US supporting an expansion of the IMF to aid Europe. Europe has both the capital and the lender of last resort to deal with this crisis themselves. They don't need external financing, they need internal rebalancing. Ultimately, the Europeans will need to find the political willpower to solve the crisis. I just don't see much US involvement in the process, either fiscal or monetary. And if such involvement did occur, it would not happen until conditions became much, much worse.

Bottom Line: The tide turned from optimism to pessimism today. Perhaps the opposite happens tomorrow. But ultimately, I believe pessimism will rule the day. The point of no return was reached when Germany and France openly discussed a smaller Eurozone. To be sure, the ECB could still offer upside surprise by serving as the lender of last resort, which would ease the downside pain. I don't anticipate the Fed will take on this role. The Fed is probably still mulling over what they perceive to be the limited US exposure to Europe, just as they did with the US subprime debt. And the relatively painless demise of MF Global probably reinforces that sense of complacency. The Fed will react eventually, but US conditions will need to deteriorate markedly before they do so.

Tuesday, November 08, 2011

I have to say, I'm puzzled. Recent developments in the euro zone seem incredibly negative to me. The probability of a reasonably orderly conclusion of the crisis appears to be falling. Yet equities aren't dropping; indeed, they're up from early September. Has the roadrunner sprinted off the cliff but not yet looked down? Or am I missing something?

Avent is trying to wrap his mind around equity market behavior. I wish him the best - I hope he gives me a call if he finds a meaningful answer. All I can say is that we have been here before. Recall 2007:

By the middle of 2007 the TED spread was exploding, signaling enormous financial turmoil. Yet equities kept heading upward, fueled by data that was just not that bad coupled with ongoing expectations that a solution was just around the corner. And now we find ourselves in almost the exact same position. Avent is correct, the news out of Europe is abysmal. He is not missing anything. There is no solution, no magic summit at hand. At this point, it is a choice between severe recession and depression. There is no happy ending to this story.

Consider the news from Greece. CR points us to Athens News, which declares the Greek government rudderless. The latest EU demand, that everyone in power sign a commitment to the last bailout proposal, might simply be the straw that broke the camel's back. The key sentence:

The demand came a day after ND issued a nonpaper saying that the party will support the new government’s policies, only to reverse them when the conservatives come to power.

The implication is that the New Democracy party hopes to pull in the next tranche of aid, then default. CR suggests they just say so, and get the default over with. I have to agree - we all know the latest haircut of 50% - not including official debtholders, of course - will prove to be insufficient, as additional austerity measures erodes the government's fiscal position.

And that story is growing throughout the Eurozone. Consider this report:

France announced 65 billion euros of tax hikes and budget cuts over five years on Monday, as President Nicolas Sarkozy seeks to protect the country's creditworthiness in financial markets without killing his chances of re-election in six months time...

...But economists said the government's growth outlook was still too optimistic, even after cutting the forecast for 2012 to 1 percent from 1.75, meaning the latest measures might not be enough for France to meet its deficit reduction goals.

As the periphery moves to austerity, it weakens the core, and the core turns to additional austerity. Which then weakens the periphery. Slow, but vicious, cycle.

Good luck with that - it has obviously worked so well in the rest of the Eurozone. Meanwhile, the 10 year Italian bond rate rose to 6.77 percent, a whopping 497bp premium to Germany. Many believe that 6 percent is the point of no return, and we are well past that mark. Italian bonds might get some relief from Berlusconi's departure, but within three to six months they too will be falling short of their fiscal benchmarks, and bond markets will be forced to react.

Meanwhile, the ECB is effectively on the sidelines. Ed Harrison at Credit Writedowns has been providing some excellent commentary, and believes it is only a matter of time before the ECB brings out the big guns and gives Europe what it needs, a lender of last resort. Which makes perfects sense because that is the only way in which the Eurozone does not fall into depression. That said, ECB members are determined to prove him wrong. From Bloomberg:

European Central Bank council member Jens Weidmann said the ECB cannot bail out governments by printing money.

“One of the severest forms of monetary policy being roped in for fiscal purposes is monetary financing, in colloquial terms also known as the financing of public debt via the money printing press,” Weidmann, who heads Germany’s Bundesbank, said in a speech in Berlin today. The prohibition of monetary financing in the euro area “is one of the most important achievements in central banking” and “specifically for Germany, it is also a key lesson from the experience of hyperinflation after World War I,” he said.

In the United States, we live under the legacy of the 1970's. For Europeans, it is the 1920's. And with that fateful decade in mind, the resistance of certain Eurozone stakeholders - yes, Germany - remains steadfastly in the path of very aggressive monetary policy.

Bottom Line: Yes, Europe is bad. And getting worse. By the time European policymakers reach an agreement, the goalposts have moved. They are literally looking into the abyss, caught like deer in the headlights. And like the US in 2007, they cannot avoid the abyss. And yet, US equities markets hang on, edging upward in the apparent belief - or delusion - that a European financial crisis will not filter back into the US. I hope that is correct, but suspect it is not. And if it not correct, I don't anticipate equities will react until it is obvious corporate profits will suffer.

Thursday, November 03, 2011

So much news, so little time. A list of items crossing my screen over the last two days, in no particular order:

Greece referendum off, at least for today. Greece Prime Minister George Papandreou backtracked on his calls for referendum, much to the relief of market participants. I hesitate to think this story is over. The citizens of Greece might not react calmly to having democracy snatched back out of hand's reach. It is never easy to put the genie back inside the bottle.

The ECB cuts rates. Better late than never, I suppose. The surprise rate cut by the ECB is also credited with bolstering markets today. Given the worsening economic situation, we should expect more sooner than later. And note that with the benchmark rate at only 1.25%, the zero bound is clearly in sight. How do you say liquidity trap in German?

Red flags in the German data. Germany, the juggernaught of the European economy, looks to be under stress. The German Purchasing Managers Index crossed over into contrationary territory last month for the first time in two years, while German unemployment rose for the first time in two years. From Bloomberg:

“It’s too early to call this a trend change in the labor market, but it shows that growth forces are weakening,” Lothar Hessler, an economist at HSBC Trinkaus & Burkhardt AG (TUB) in Dusseldorf, said in an interview. “The dynamism of the economic upswing is lessening more than thought.”

I am more willing to call a shift in Germany's labor market - the austerity that Germany is fond of foisting on the rest of Europe is coming home to roost.

Italian economy also shifted into low gear. The Italian PMI dropped a whopping 5 points to 43.3, a notch below Spain's 43.9. No wonder Italy's Prime Minister Silvio Berlusconi is having trouble pushing through another austerity package. Rebecca Wilder highlights the importance of growing political risk in Italy:

Another driver of the increasing Italian risk premium is political risk. You can see this in the spread between Italian 10yr bond yields and the Spanish 10yr bond yields, which has collapsed since the summer and is now trading at -70 bps. That means the Spanish sovereign is borrowing at a 10yr yield that is 70 bps cheap to Italy, where it used to pay a premium. Something idiosyncratic is going on with Italy.

It is tough to see how a Europe still struggling to put a ring around Greece can find the time and resolve to get a ring around Italy as well.

The retailer was hurt by a “slowing trend” in the region, while same-store sales in Japan and Canada continued to decline, according to a statement today. The shares slumped 21 percent to $58.50 at 10:53 a.m. in New York after dropping as much as 23 percent for the biggest intraday loss since Nov. 30, 2000.

Abercrombie & Fitch surprised investors after Chief Executive Officer Michael Jeffries said in August that there was a “strong momentum” in Europe. The retailer is joining a growing list of consumer companies, from Whirlpool Corp. to Kimberly-Clark Corp., that saw a slowdown in the region mired by a sovereign debt crisis.

The US service sector comes in on the soft side. The ISM nonmanufacturing headline number was down slightly, with mixed internals. Production came in down 3.3 points, while new orders dropped 4.1 points. Both measures held above 50. On the postive side, the employment component rebounded, offering some hope for tomorrow's employment situation report. In related new, initial unemployment claims edged below 400k. Overall, Calculated Risk is not impressed, expecting another weak report.

The Fed hold steady. Mark Thoma has the story here. Inexplicably, monetary policymakers slashed forecasts, claimed dissapointment at the state of the economy, and yet choose to take no policy action. The path to additional action is blocked by the lack of clear indications of deflation risks. The economy is bad, just not bad enough.

Another financial casaulty of the European crisis? First was Dexia, next was MF Global. Is Jefferies Group the third to fall? That was concern today as investors took the stock down 20% before it rebounded. More disconcerting is the message the price actions sends about the vulverability of US financial markets to European contagion:

“It is a testament to the fragile nature of the markets that the collapse of MF Global, following a monumental display of bad judgment by that company’s management, should generate contagion,” said Chris Kotowski, an Oppenheimer & Co. analyst in New York. Jefferies is “a very conservatively run firm where management has enormous ‘skin in the game.’”

Bottom Line: This is starting to feel like 2007 all over again. Then, like now, equity markets discounted the smoldering financial crisis, sending stocks higher through much of that year. I continue to think Europe is much further from a solution than American observers appear to believe, and that as the global situation deteriorates further, so too will the US economy. But we have yet to see that story fully emerge in the US data, and thus I understand the hope that the US is able to squeak through this episode with only limited bruising.

Tuesday, November 01, 2011

The break down in the relationship between consumer confidence and actual spending is something that has been nagging at me for awhile. This picture:

While confidence is at recession levels, real personal consumption expenditures continue to grow at a reasonable clip. Should confidence numbers be totally dismissed, or do they signal an underlying fragility among households that should not be ignored? Some hints at an answer may be found in the September income and spending report. Notably, real personal disposable income looks to have rolled over:

So where is the spending power coming from? A plunge in the saving rate:

It looks like households are struggling to hold onto the even meager spending gains achieved since the recession ended, and that struggle may be what is reflected in the consumer confidence numbers. Overall, this suggests to me that consumer spending is much more fragile than commonly believed.

Manufacturing activity also looks shaky. To be sure, it is reasonable to expect some momentum from the surge in equipment spending in the third quarter. But it is also reasonable to believe that some of this demand was pulled forward as firms try to get ahead of the expiration of the accelerated depreciation benefit. And even with that surge, note the ISM report surprised on the downside this morning. On the positive side, the new orders measure climbed back above 50, while on the negative, both the export and import components fell. The latter point is a troubling indication of spillover from slowing manufacturing activity in China and Europe. A contraction in global activity isn't exactly what we need at this juncture, especially as it will first bleed through to what has been one of the bright spots in the US recovery.

Bottom Line: With all attention focused on the Greek drama, plus the well-received Q3 GDP report, it has been easy to overlook the underlying fragility in the US economy. This was especially the case when US equities looked to be on a nonstop trip to the moon. Perhaps the US economy can squeak through the next few quarters, and perhaps, in contrast to my expectations, Europe is able to bring an end to the crisis with limited collateral damage to the economy. But I can't shake the feeling that the US economy closer to running on fumes than is commonly believed, and will run out of gas in a very hostile global environment.

The reality of the worsening European situation came home to roost on Wall Street this week. Last week's "summit to end all summits" offered up only broad brush strokes to begin with, and even those were rapidly erased by plans for a Greek referendum on the deal. A rumor circulated earlier today that the referendum was dead, but that has since been refuted by the Greek government. It appears that either the Greek government collapses or the referendum will occur - and neither outcome is good for market participants looking for certainty in these uncertain times.

Let me suggest this as well - that even if Greece comes back on board with the existing agreement, the damage is already done. Three thoughts today:

A deepening Eurozone recession is inevitable. Even if full-blown financial crisis is avoided, the cost will be continued austerity programs that will sink the Eurozone economy ever deeper into recession. This will only exacerbate the problems facing European banks as nonperforming loans rise, which will be on top of the credit contraction to follow plans to have banks recapitalizing themselves with private money by next summer.

The unintended consequences of the EFSF. The EFSF was already a farce to begin with, underfunded and relying on leverage to cover up a lack of money. The farce continued as European leaders sought handouts from China to fund a project they themselves were not committed to. Then the lack of details within the latest plan is hampering the ability of the EFSF to issue debt. From the FT (hat tip to Zero Hedge):

The bond from the European financial stability facility will seek to raise €3bn ($4bn) and will be in 10-year bonds rather than a 15-year maturity because of worries over demand, say bankers. A 10-year bond is more likely to attract interest from Asian central banks than a longer maturity.

Bankers familiar with the issue said the EFSF had been considering a €5bn issue. However, the EFSF has denied this, saying it had always sought a €3bn issue...

...EFSF officials decided to price this week because market conditions might deteriorate if they hold off any longer, according to bankers.

The bond is expected to price at yields of about 3.30 per cent, about 130 basis points over ­Germany, the European market benchmark. This represents a big mark-up since the middle of September, when existing 10-year EFSF bonds were trading at about 2.60 per cent, only 70bp over Germany.

Now the insurance component of the EFSF is blowing back in their faces. From the FT:

“It is kind of ironic: it is Draghi’s first day. His first decision is ‘yes, buy Italian bonds’,” said Gary Jenkins, head of fixed income at Evolution Securities. He added that the move to make Europe’s rescue fund, the European financial stability facility, issue insurance on new Italian and Spanish debt was deterring buyers: “They have created a situation where the only people buying Italian debt are themselves.”

A trader of Italian government bonds said: “It was meltdown at one point before the ECB came in. There were no prices in Italian government bonds. That is almost unheard of in a big market like Italy. There were just no buyers and therefore no prices.”

By not creating a backstop for previously issued bonds, the Europeans have clearly identified those bonds at risk of default. If the Europeans are not willing to buy or insure the bonds, why should investors? Answer: They shouldn't. Consequently, the ECB was forced to do what it hates, buy Italian debt, and even then yields climbed above 6%, nearing levels that many believe is the point of no return for Italy.

Moreover, one should question the what is the meaning of "insurance" for Europe. I can't imagine the ESFS actually making good on any promises to insure bondholders, as the Europeans appear adept at defining defaults as "voluntary" and therefore not credit events covered by insurance.

Will the ECB be Europe's white knight? I think we all agree that lacking a lender of last resort, Europe has something of a credibility problem. As in, no credibility. And it has been pointed out repeatedly that the ECB could step into this role. After all, we are talking about the future of the Euro, which should be something of a concern for central bankers. And, as noted by Kash Mansori at The Street Light, by guaranteeing a price for Italian debt, the ECB would like have to buy far less than they think. But here is the problem - why should the Italians get an ECB backstop at 6%, while the Irish pay 8% and the Portuguese 12%? Politically, the ECB needs to backstop either everybody equally or nobody. Setting a ceiling on Italian debt alone risks setting off a firestorm of public anger within those nations already struggling under the weight of austerity programs. And note that even if the ECB does come into the fight, the will only do so in return for additional austerity. In other words, they might stave off financial collapse, but not recession.

Bottom Line: No matter how many summits they have, there is no easy out for the Europeans at this point.